Topic: Growth Stocks

Edwards Lifesciences’s high R&D spending conceals its true profitability

A Member of Pat McKeough’s Inner Circle recently asked for his advice on a healthcare company that develops heart disease technologies and products.

Pat likes the firm’s consistently rising revenue, strong balance sheet with low debt, as well as its relative resilience to COVID-19 complications. However, its high R&D spending makes the firm appear less profitable than it really is.

Edwards Lifesciences (Symbol EW; www.edwards.com), is focused on developing technologies and products that treat structural heart disease and critically ill patients.

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The company operates in four segments: Transcatheter Aortic Valve Replacement (66% of revenue), Surgical Structural Heart (17%), Critical Care (16%), and Transcatheter Mitral and Tricuspid (1%).

Medical-device supplier Baxter International (symbol BAX on New York) spun off Edwards Lifesciences in March 2000. Baxter shareholders received one share of Edwards Lifesciences stock for every five shares of Baxter stock they owned. We first recommended Baxter in our December 1999 inaugural issue of Wall Street Stock Forecaster and it’s still a pick of that newsletter.

Edwards is a leader in a procedure called transcatheter aortic valve replacement, or TAVR. The procedure allows for patients with aortic stenosis (narrowing of the valves) to have a heart valve replaced via a catheter. That removes the need for full open-heart surgery, and it speeds up recovery. The transcatheter procedure can also lower total health-care costs since hospital stays are shorter.

Aortic stenosis typically occurs when calcium builds up in the valve, limiting the amount of blood pumped into the aorta, the body’s largest artery. That causes fatigue and shortness of breath.

TAVR isn’t a new procedure, and it’s expensive, but the pool of patients who can benefit is large and growing. Specifically, more than five million U.S. adults have aortic valve disease and that number is increasing as the population ages. Rising obesity levels and the growing number of aortic stenosis patients will also spur demand.

As well, the expanding variety of valve sizes will work for more patients, at the same time growing clinician experience with the procedure and strong clinical evidence supporting TAVR’s efficacy will also drive patient interest. That will also reduce risks and costs compared with other heart surgeries.

Inner Circle: Revenue growth is steady and the balance sheet is strong

Edwards’ revenue grew steadily between 2017 and 2019—rising 26.6%, from $3.44 billion in 2017 to $4.35 billion in 2019. Revenue then grew just 0.8% in 2020 to $4.39 billion. The impact of the COVID-19 pandemic slowed the number of heart procedures being performed worldwide in 2020.

Revenue then climbed 19.3% in 2021, to $5.23 billion. That gain came despite the Delta variant (and later Omicron), which impacted the rate of heart procedures performed worldwide.

Earnings per share rose 46.5%, from $1.27 in 2017 to $1.86 in 2019. (All figures reflect the company’s 3-for-1 stock split in June 2020.) Earnings were then unchanged in 2020 at $1.86 a share. In 2021, earnings per share rose along with revenue, up 19.4% to $2.22 a share.

In the three months ended December 31, 2021, the company saw sales rise 11.6% to $1.33 billion from $1.19 billion a year earlier. Sales were helped by increased demand for TARV procedures. TARV sales, in fact, rose 13% from a year earlier—and despite the Omicron variant having a pronounced impact on hospital resources in December.

Excluding one-time items, earnings rose 1.3%, to $320.3 million, or $0.51 a share, in the quarter, from $316.2 million, or $0.50.

Edwards’ balance sheet is strong: it holds cash of $1.5 billion and its long-term debt is $595.7 million, or just 1% of its market cap.

The company devotes 17% of its sales to research and development. These high outlays get deducted from its income the year in which that money is spent; that depresses its earnings and makes the company look less profitable than it is.

Still, those investments help Edwards to stay ahead of the competition, which includes Medtronic (symbol MDT on New York) and Boston Scientific (symbol BSX on New York and a recommendation of our Power Growth Investor newsletter).

Edwards’ outlook is positive even with uncertainty surrounding COVID-19 and its variants. That’s because patients with heart ailments, especially aortic stenosis, cannot delay seeking valve replacements for too long without seriously endangering their health.

Recommendation in Pat’s Inner Circle: Edwards Lifesciences is a hold.

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